Pensions Act 1995 (PA) - The PA requires courts to take pension rights into account when assessing assets on divorce. It introduced the concepts of earmarking pension benefits as well as the basis for cash equivalent transfer values (CETVs) for assessing the value of a pension on divorce.

Welfare Reform and Pensions Act 1999 - The Act brought in the option of Pension Sharing On Divorce from December 2000. The thrust of the legislation is to attempt a ‘clean break’ settlement for pension funds on divorce. The legislation states that pension benefits will still be taken into account in divorce settlements. Offsetting and earmarking will still be options to consider, however a new (and probably much more appropriate) option was introduced which allows the pension benefits to be shared or split between the parties at the time of the divorce.

2. OFFSETTING

This simply means that the pension funds are valued, and the spouse with greater benefits provides the other spouse with additional funds elsewhere in the settlement, to compensate them for the loss in pension rights.

In an ideal world, this system would be by far the simplest and arguably the best solution. Unfortunately, however, many people do not have sufficient assets to enable offsetting.

3. EARMARKING

Earmarking applies to all private pensions (including those in payment), but not state benefits.

It involves the court issuing an attachment order to the pension scheme. This attachment requires the scheme’s trustees to pay a proportion of the member’s benefits directly to the ex-spouse, when the benefits are taken.

The court can also earmark a proportion of the member’s ‘death in service’ lump sum, and widow(er)’s pension benefits, for the protection of their ex-spouse.

Earmarking has many problems, not least that the pension remains under the control of the member. If he or she decides not to retire, invest riskily, or take any other action prejudicial to the ex-spouse there is nothing that they can do about it. In addition:

If the petitioner remarries, the earmarking lapses.

Earmarked benefits are all taxed at the highest rate of the pensioner, irrespective of the tax rate for the ex-spouse.

If there is the likelihood that the petitioner will remarry prior to the respondent’s retirement age, then - except for some safeguard on the life cover side - this procedure is probably a costly waste of time.

4. PENSION SHARING

Pension sharing applies to all pensions, apart from the state basic old age pension.

All pension benefits are valued (see CETV below). The share can be granted by way of a transfer to the petitioner’s own scheme, or the petitioner may become a ‘paid up’ member of the respondent’s company pension scheme.

This latter option is rarely used, as the retaining scheme will not wish to have the increased costs, disclosure requirements and administrative inconvenience associated with additional members (non-employees).

The rules allow schemes to insist on ‘buying out’ the spouse’s benefits, if the scheme considers it appropriate. Most schemes insist on this route. The exception is usually the government and Local Authority schemes, which are ‘pay as you go’ (unfunded except for the local government scheme) and therefore reluctant to pay large transfer values.

Pensions that are already in payment (eg. through an annuity) can be ‘unbought’, split and ‘rebought’ using the annuity rates for the member and petitioner at date of divorce. Indeed, if the petitioner is much younger, they can use the lump sum as a pension contribution (or many other alternatives).

The biggest problem with pension sharing is the cost. Schemes are entitled to charge for the calculations and administration involved in splitting the benefits. The recipient must also consider the cost of any required financial advice, which may make the entire process uneconomical.

At present, little consideration has been given to “co-habitant” relationships, although it is the subject of significant lobbying.

5. CASH EQUIVALENT TRANSFER VALUE (CETV)

A CETV represents the expected cost of providing the member's benefits within the scheme. In the case of money purchase benefits, this is generally straightforward – it is the accumulated contributions made by and on behalf of the member together with investment returns. In the case of defined benefits, the CETV is a value determined on actuarial principles, which requires assumptions to be made about the future course of events affecting the scheme and the member's benefits.

6. SUMMARY

We expect pension sharing to be used in the vast majority of divorce cases, where offsetting is not an option. Cost will, however, be a key issue. Any transfers will have to be sufficient to warrant the large costs involved in calculating and organising the new arrangements.

A pension is a long term investment. The fund value may fluctuate and can go down. Your eventual income may depend on the size of the fund at retirement, future interest rates and tax legislation.

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